Inflation & Interest Rates: share your data sources, models, and assumptions

[MustacheAndaHalf]

Thanks, @MustacheAndaHalf .  Really interesting perspective, since this was the method in effect during the 1970's.  Thank God the Fed didn't have to raise rates to 20% to tame it.

The Fed seems intent on "higher for longer", and maybe this research paper adds confidence to that approach.  If the cost of borrowing is a hidden ingredient in inflation, then inflation could be higher than expected.

There is also a feedback loop that confuses me... The Fed lowers rates, which lowers the cost of borrowing.  CPI inflation, according to that paper, should include the cost of borrowing... so CPI inflation drops when the Fed lowers rates.  Seems like a feedback loop that would make predictions difficult.

[ChpBstrd]

E.g.
In a particular year, prices are increasing 10% and rates are 1%. If borrowing costs are included in our inflation stat, maybe inflation is significantly less than 10% and the Fed fails to grasp the severity of the inflation problem.

E.g.#2
In another particular year, prices are increasing 1% but rates are 10%. If borrowing costs are included in our inflation stat, maybe the Fed acts as if prices are rising much slower than 10% and fails to grasp the urgency of loosening policy.

Did these scenarios ever occur?

In that first scenario, I could borrow at 1% then buy commodities that increase at 10%, and profit off inflation.

Well, the numbers are exaggerated to make a point. But even if there was a 0.25% or 0.5% difference between actual aggregated price changes versus an inflation number that included the cost of borrowing, that could be enough to delay a FOMC action by months.

12-month Core PCE was recently reported at 2.8% and markets are pricing in a rate cut in the June meeting. If borrowing costs were included in PCE and the core number was, let's say, 3.1% instead of 2.8%, then maybe the first rate cut would come in September or November instead of June. This difference in the Fed's ability to react to rapid disinflation would actually only be an artifact of how things were measured, and the fact that part of the measurement of inflation was a measurement of the Fed's own policy.

It would be a subtle influence saying "because real rates are high/low, policy should stay tight/loose as it already is" despite whatever prices for goods and services were doing.

[FIPurpose]

They don't mention the possibility of selection bias, just randomly adding in new numbers to make today's numbers make more sense. I think consumer sentiment makes more sense in light of social reasons, not financial ones. Anxiety over global warming, war, social media echo chambers. I would've liked them to compare their theory against a few other metrics as at least a control, they only use some "trust in government" metric which feels like a checkbox that they did some comparison.

We all know the conservative guys that regularly complain about the economy, but when you ask for specifics suddenly they can't really point to anything except maybe mortgage rates or the 3 months when egg prices were high last year. They're doing fine financially, politically charged language is just training people to be negative on the economy. I would've liked to see more comparison around this.

I've seen graphs comparing Democrats and Republicans, and they flip when the Presidency flips.  It seems like the high side of consumer confidence reflects who controls the White House.  That said, the average does reflect changing economic conditions, taking severe drops during the Covid pandemic, for one.

If charged language is a big factor in consumer sentiment, shouldn't it be trending downwards every year for the past decade?  That isn't what I've seen, but maybe I'm misinterpreting what you said.

Democratic consumer sentiment is largely the same under Biden as it was under Trump. There was a small wave with Covid and Biden taking office, but it settled more or less in line with Trump's years. It's conservative sentiment that went up 40 point at the beginning of Trump's presidency dropped 40 points during covid and then dropped another 40 points for Biden.

I think that points to conservatives being much more influenced by media and other factors outside the realities of the economy.

It also might mean that the fall in consumer sentiment is being driven by conservatives. Democratic sentiment is largely flat.

I bet if we normalized the sentiment by whose party is in office, we'd see a small blip at covid for 2020-2021, but a mostly flat line between Trump and Biden otherwise.

[ChpBstrd]

This is what organic economic growth, unencumbered by stimulus, looks like.

Money supply has been flat since March 2023...


...but the velocity of money has plowed steadily upward:


This is the opposite of a credit crunch. A relatively finite supply of money is changing hands at a faster and faster pace, amid full employment and loose financial conditions.

As a consequence of rising wealth inequality (think large pools of money that isn't being spent often), a rapidly increasing money supply, and growth in international dollar accounts, velocity had been on a downward trend for years. So an uptick in velocity is nothing to be concerned about - it's merely a reflection that GDP is growing quickly amid a flat money supply. Likewise, it is hard to imagine how a flat money supply could constrain GDP growth in the near future, after the massive post-pandemic increase.

However I do wonder if modestly rising defaults on consumer loans, credit cards, and mortgages reflect an imbalance in who owns the money supply. A falling personal savings rate in light of these metrics, suggests regular consumers may be struggling to keep their inflating bills paid, despite all the economic activity and jobs. I might be concerned if annualized wage growth was not exceeding CPI by about 1.3%. This gap offers an explanation for how consumers will dig out of the holes they dug in the 26 months when inflation was exceeding wage increases. I remain cautiously optimistic, but I'm keeping a close eye on the banks.

[MustacheAndaHalf]

Maybe we have different data or different observations, so below is the graph I'm using for consumer sentiment from 2016-2024.  With a Republican White House, Republicans were +20 over independents, and Democrats -20.  Once the White House flipped, so did the numbers: Democrats +20 and Republicans -20 (again compared to independents).
https://www.reuters.com/graphics/USA-ECONOMY/SENTIMENT-POLITICS/gkvlgqjzxpb/index.html

Another view is just to look at independents, and how their confidence fell during 2020 with the pandemic.  I think inflation picked up in 2021, which again hurt consumer confidence.  Going solely on consumer confidence, something is still wrong.  Of course, I would say that - because I believe that as well (that's my bias).

[FIPurpose]

Maybe we have different data or different observations, so below is the graph I'm using for consumer sentiment from 2016-2024.  With a Republican White House, Republicans were +20 over independents, and Democrats -20.  Once the White House flipped, so did the numbers: Democrats +20 and Republicans -20 (again compared to independents).
https://www.reuters.com/graphics/USA-ECONOMY/SENTIMENT-POLITICS/gkvlgqjzxpb/index.html

Another view is just to look at independents, and how their confidence fell during 2020 with the pandemic.  I think inflation picked up in 2021, which again hurt consumer confidence.  Going solely on consumer confidence, something is still wrong.  Of course, I would say that - because I believe that as well (that's my bias).

I think independents are really just a half and half mix of conservatives and liberals that for whatever reason don't want to identify with the party that they most align with, so it makes sense that they would always be in the middle.

That's the graph I was using, and I do think you're missing something in it.

The baseline at the end of Obama is about
D: 100
R: 80

Trump takes office
D: 80 (-20)
R: 120 (+40)

Covid happens
D: 60 (-20)
R: 100 (-20) - which is crazy that R's still felt better about the economy here than under Obama.

Leading up to 2020 election:
D: 75 (+15)
R: 85 (-15)

Biden takes office:
D: 100 (+25)
R: 60 (-25)

1 year into Biden it settles at:
D: 80 (-20)
R: 40 (-20)

The most interesting number here to me is that Dem's are at the same confidence now with Biden as with their Trump years. Compare the blue and red lines, the only one that really switches positions there is the Red one. A small blip with Covid and positive feelings around Biden/Covid Recovery for D's, but they have been more or less flat for the past 8 years.

1. Covid complicates the timeline, but to me it reads that Dem's swing 20 points with presidents, R's swing 40 points.
Both parties lost 20 points with Covid
2. Under Trump's covid recovery, Dem's eventually had a positive outlook on the recovery and came back 20 points. R's did not like Trump's covid recovery and lost another 20 points.

Those 2 points are able to explain the whole graph to me.

[ChpBstrd]

February CPI is reported tomorrow. The mix of positive and negative factors suggest it will be in line with expectations.

• The S&P GSCI commodities index rose about 5% during the month of February, and crude oil rose about 6.5%. This suggests a higher-than-expected CPI.
• Annual hourly earnings growth is at +4.38%, and was up +0.14% in February. That's a lot less than the +0.524% we saw in January. This suggests wage pressures on prices went down in February, which would be disinflationary.
• Initial claims trended slightly higher in February. This suggests demand might have fallen very slightly, which would be disinflationary.
• Forecasts are for CPI to increase about 3% or 3.1% YoY. This is about the same as January, when commodities and hourly earnings rose even more than they did in Feb, but the initial claims trend was slightly lower.

The Cleveland Fed's nowcast model predicts CPI will be up 0.43% (3.12% annual) and Core CPI will be up 0.32% (3.7% annual). I think that's a reasonable guess, so I'll make that my prediction too.

[dividendman]

CPI 3.2%, core 3.8%. Higher than the Cleveland Fed's model. People are still betting ( >50% chance) on rate decreases later in the year though.

[MrGreen]

Do we think rates staying where they are is going to be enough to "unstick" inflation or is the Fed actually going to have to raise rates again? I think that would be the final psychological straw. If rates stayed where they are most of the year and then the Fed raises them another quarter point that would shatter any illusion people still have that things are "coming down soon." The psychological effect could end up dwarfing the actual effect of a quarter point hike.

[reeshau]

I think there is a good chance rates continue to drop in the next few months, as the Core PCE ratings which will be lapped are still relatively high.

It could get complicated if the Fed waits to July, though, as there are several months from the back half of 2023 where the monthly rating was just 0.1%.  That could give a good chance for rates to increase just after the first cut, or to hold off cuts until they clear.

Of course, just in time for election narratives, too.

[FIPurpose]

I think we should also think of the fed starting to lower rates doesn't require 2% inflation.

The current target is 5.5 and we've had pretty consistent inflation at about the 3.5% rate. Cutting the rate to ~5% this year doesn't really seem that extreme in this environment.

[ChpBstrd]

A reduction in the rate of disinflation (inflation falling at a slower pace) is validating JPow's August 2023 comment that we should expect rates to remain higher for longer.



For example, consider the following 4-month periods:

May 2023 - August 2023 decrease in Core PCE: -0.96%
October 2023 - January 2024 decrease in Core PCE: -0.54%

So this is weird. Rates were HIGHER after the final hike in August 2023 and yet the rate of disinflation slowed after that point. That is to say, the economy is receiving MORE medicine and yet experiencing a smaller effect. We can't blame money supply, which has been relatively flat for the past 12 months, and we can't blame QT, which was constant the whole time.

Maybe going from 3% to 2% is inherently harder than going from 5.5% to 4.5%? Maybe there's a mathematical or methodological explanation? Or maybe the economy is just running at white hot full speed mode and a 5.5% FFR upper limit plus QT are the only things keeping inflation down in the 3% range?

I once had a small ski boat that would stick its bow in the air and plow its stern through the water when the engine was given full throttle, but then it would eventually "plane out," adopt a more efficient orientation to the water with the bow down, and start quickly skating along the surface. Once on a plane, it would move faster with half the throttle than it was doing at full throttle plowing with the bow up.

Maybe the economy hit "plane" in some way during 2023, and is now accelerating, even as we dialed back the throttle with more restrictive policy. With real overnight rates at about +2.5% we seem to be just barely constraining inflation.

Another vehicular metaphor is that the airplane making a "soft landing" reduces its angle to the ground as the runway approaches, and slows its descent. A soft landing is becoming more likely as the rate of disinflation slows, and our angle of approach declines as we close in on the target.

Maybe the effect of QT has been offset by monetized government deficits ($+315B higher deficit last year vs. 2022 versus -1.14T in QT during 2023) and other factors such as $163B lent under the BTFP, so that money supply has flatlined.
 

This caught me by surprise. I expected constant QT to lead to a falling money supply. But instead we are stimulating the economy at the bottom end with increased government spending and loans to banks, while we are restraining inflation by reducing money supply at the top end, through QT. Those effects together seem to be leading us to a very strong economy and well-contained inflation, despite moderately high real interest rates.

This just-right economic configuration could go on for a long time. It is essentially the taking of two medicines at once - a medicine to stimulate the economy and a medicine to keep inflation down. However I didn't expect "higher-for-longer" to mean any rate cuts would be questionable until the end of 2024. Now there's a lot of talk about keeping rates where they are if things are going so well. In a historical sense, a 12-month Federal Funds Rate plateau at 5.25%-5.5% that ended in August 2024 would be consistent with the Fed's behavior in 2006-2007.

[Paper Chaser]

-- CPI seems stuck at 3%:


-- This chart shows the sub-categories of CPI that are seeing inflation of 4% or more. Looks to have bottomed out mid-2023 and generally rising since (although small sample since then):


-- Supercore CPI (note transportation):



-- This chart shows a breakdown of the transportation sub category. Look at the impact that increasing car insurance has made:


Also noteworthy that "goods" saw actual deflation, while "services" remained around 3.8%. Seems like the supply chain crunch has mostly been processed and dealt with.

[ChpBstrd]

Also noteworthy that "goods" saw actual deflation, while "services" remained around 3.8%. Seems like the supply chain crunch has mostly been processed and dealt with.

Goods deflation in the U.S. partially reflects deflation in China, so that one is easy enough to explain away.

Services (aside from shelter and energy) are essentially the markup of wages, so in the long run it seems reasonable to expect services inflation to loosely track wages.

Q4 hourly compensation for services workers was 4.18% higher than a year ago, while services inflation excluding shelter and energy for January was only about 3.52%. That suggests the cost of providing services is rising faster than the prices obtained for services, implying that business margins are shrinking.

However the longer-range view shows that hourly earnings can outpace the cost of services excluding shelter and energy for a very long time in a low-inflation environment of steady growth, so we can't read too much into the last few months. Nor can we say prices must converge with wages.


https://fred.stlouisfed.org/graph/?g=1ieTL

[maizefolk]

Q4 hourly compensation for services workers was 4.18% higher than a year ago, while services inflation excluding shelter and energy for January was only about 3.52%. That suggests the cost of providing services is rising faster than the prices obtained for services, implying that business margins are shrinking.

This holds up is we assume flat productivity in the service sector.

To be fair, it's historically been a sector that is less amenable to substituting capital for labor, but particularly at the low end wages are up a LOT in the last four years and my guess is that we'll continue to see more and more investments in ways to provide more services with less labor.

[MustacheAndaHalf]

Surprise inflation right before a Fed meeting.  I assume that pushes the chance of a rate cut even lower.

"Wholesale inflation rose 0.6% in February, much more than expected"
"Two-thirds of the rise in headline PPI came from a 1.2% surge in goods prices, the biggest increase since August 2023, thanks to a 4.4% jump in energy."
https://www.cnbc.com/2024/03/14/producer-price-index-february-2024-wholesale-inflation-rose-0point6percent-in-february.html

[ChpBstrd]

Seasonally adjusted PPI came in "hot" at +0.6% in February, and +1.6% for the trailing 12 months. Gains were driven by gasoline and diesel for goods and hotel accommodations for services. Core PPI, excluding food, energy, and trade services was up 2.8% over the trailing 12 months.

The Russell 2000 small cap index dropped 1.6%, while the S&P500 and Nasdaq were modestly down.

First, 1.6% is not historically out of whack, and PPI is very volatile, so I wouldn't forecast any long-term trends off these data.

My thoughts are more like:

"We already knew commodities rose sharply in February, and we learned yesterday that CPI exceeded expectations in February, so why is anyone in the market surprised that PPI came in a little high? Couldn't a person armed with the bad news data that were available yesterday have anticipated bad news for the PPI and used an option spread to bet that stocks wouldn't rise beyond a certain level this morning?

PCE and CPI are correlated. Doesn't this mean stocks won't rise very much on the day after PCE is released on March 29, and a bear spread would be a good play on that day?"

Reasons to doubt this rationale include a lower weighting of shelter in PCE (16.8% in recent years) versus CPI (32.9% in recent years). Shelter was up 0.4% in the CPI report, though this matched the overall 0.4% CPI gain so arguably it wasn't a bigger effect than everything else. Then there's Wednesday's 1.12% rise in the S&P500 despite the supposedly "hot" inflation report. Maybe if one was gong to play a bear spread at the end of the day on March 28, one would bet the indices would not go up more than about 1.5% that day.

I checked spread prices around these levels this morning, and unfortunately the payouts are minuscule - pennies in front of a steamroller. One would be better off simply selling their shares on the 28th and buying them back on the 29th.

[Paper Chaser]

FOMC release for March showed higher predictions for GDP in 2024, some rate cuts still on the table for 2024, but fewer FOMC members predicting a return to super low interest rates too. Higher for longer, or just a return to more historically normal interest rates?

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240320.pdf

[MustacheAndaHalf]

“The U.S. LEI rose in February 2024 for the first time since February 2022,”
https://www.conference-board.org/topics/us-leading-indicators

Instead of finding that data myself, I let Twitter find it for me.  In this case, Liz Ann Sanders  (Chief Investment Strategist, Charles Schwab & Co) brought it to my attention.
https://twitter.com/LizAnnSonders/status/1770818422416556252

[ChpBstrd]

Markets will be closed on Friday, the day PCE and core PCE are released.

I think both will be perceived as bad news, though mitigated by last week's dot plot. CPI and PPI were both on the high end, so PCE will be high as well.

Expect a flat-to-down week - a good opportunity for covered calls or speculative bear spreads.

[Financial.Velociraptor]

Markets will be closed on Friday, the day PCE and core PCE are released.

I think both will be perceived as bad news, though mitigated by last week's dot plot. CPI and PPI were both on the high end, so PCE will be high as well.

Expect a flat-to-down week - a good opportunity for covered calls or speculative bear spreads.

If PCE is foretold by CPI/PPI, why is this not "priced in"?   I don't really follow.  I hadn't noticed that PCE was being released on a market holiday. A Friday no less.  Doesn't this suggest a low volatility response as the markets have a full weekend to digest the data?  I expect some posturing and even flagging behavior by the big funds in premarket but the overall direction of the market should be more or less known by 5PM eastern time Friday? 

Maybe you know something I don't but I smell "low vol" week.

[ChpBstrd]

Markets will be closed on Friday, the day PCE and core PCE are released.

I think both will be perceived as bad news, though mitigated by last week's dot plot. CPI and PPI were both on the high end, so PCE will be high as well.

Expect a flat-to-down week - a good opportunity for covered calls or speculative bear spreads.

If PCE is foretold by CPI/PPI, why is this not "priced in"?   I don't really follow.  I hadn't noticed that PCE was being released on a market holiday. A Friday no less.  Doesn't this suggest a low volatility response as the markets have a full weekend to digest the data?  I expect some posturing and even flagging behavior by the big funds in premarket but the overall direction of the market should be more or less known by 5PM eastern time Friday? 

Maybe you know something I don't but I smell "low vol" week.

Yes, low-vol an low-movement is what I'm expecting too. PCE is correlated with CPI, as they are both measures of a similar concept from different points and with different weightings. I don't think a disappointing PCE is "priced in" because a disappointing CPI and PPI were not priced in earlier this month. So I'm extrapolating these market drops to the PCE release. Solid February employment numbers, rising corporate earnings, and rising commodities, should have tipped us off to a rising CPI and PPI, and all these stats should tip us off to a rising PCE. The personal savings rate would have to rise by a lot for PCE to buck the trend.

[ChpBstrd]

According to CNN's economic calendar, the forecast is:

PCE:           +0.4% monthly     +2.5% annualized, up from 2.4% in January
Core PCE:   +0.3% monthly      +2.8% annualized, same as January

Looking ahead to March CPI, to be reported April 10, it seems commodities are still rallying. Commodities have been the most reliable predictor of the past couple of years for whether inflation will be a surprise. So I think it's entirely possible the March CPI number will be at the high end of estimates too. I wonder if the Fed's March dot plot will provide the same comfort to investors as it did this month.

[Paper Chaser]

I wonder if the Fed's March dot plot will provide the same comfort to investors as it did this month.

The Fed's Summary of Economic Projections (including the Dot plot) are only released quarterly (March, June, September, and December).

[ChpBstrd]

I wonder if the Fed's March dot plot will provide the same comfort to investors as it did this month.

The Fed's Summary of Economic Projections (including the Dot plot) are only released quarterly (March, June, September, and December).

Right. I was thinking in terms of it being old news by next month, and the months thereafter.

[Paper Chaser]

I wonder if the Fed's March dot plot will provide the same comfort to investors as it did this month.

The Fed's Summary of Economic Projections (including the Dot plot) are only released quarterly (March, June, September, and December).

Right. I was thinking in terms of it being old news by next month, and the months thereafter.

Oh, gotcha. The market only responds to current news as far as I can tell. I doubt the March Dot Plot will be remembered in a month.

[ChpBstrd]

According to CNN's economic calendar, the forecast is:

PCE:           +0.4% monthly     +2.5% annualized, up from 2.4% in January
Core PCE:   +0.3% monthly      +2.8% annualized, same as January

Looking ahead to March CPI, to be reported April 10, it seems commodities are still rallying. Commodities have been the most reliable predictor of the past couple of years for whether inflation will be a surprise. So I think it's entirely possible the March CPI number will be at the high end of estimates too. I wonder if the Fed's March dot plot will provide the same comfort to investors as it did this month.

The forecasters nailed it on February PCE:

PCE:         +0.3% monthly      +2.5% annualized
Core PCE:  +0.3% monthly      +2.8% annualized

So annualized PCE rose a tenth and Core PCE fell a tenth, compared to January. Both annualized numbers are lower than they were December, so they could be perceived as an intact trend of slowly falling inflation.

[ChpBstrd]

After a brief blip in 3Q2023, house prices fell in 4Q2023:

Houses are now 12.89% less expensive than at the peak in 4Q2022 and could still be falling back toward more sustainable levels. This will eventually affect the inflation stats, with the requisite delay.

This means a typical buyer in late 2022, who put down the median 13% down payment, has accumulated no equity. Typical first-time home buyers, putting down a single-digit percent down payment, are now underwater.

I wonder how far prices can fall until the psychology shifts on home ownership. The people who were sold on the media story of a housing shortage in 2022 are now down 13% on a leveraged investment, and they're watching rents fall in an economic situation where it's cheaper to rent than to buy in all of the U.S's major metro areas.

It may be hard to imagine a foreclosure crisis with demand still strong, unemployment near all time lows, and wage growth exceeding inflation, but we need to imagine what would happen if prices fell another 13% in the next 12 months. Another 13% fall would only take us back to where prices were in late 2020 / early 2021 when mortgages were much cheaper than they are today.

Don't say it cannot happen, because it just did. Prices just fell 13% in 12 months and are still way out of whack with historical price/rent and price/income ratios.

If you are 100k underwater on a house with a 7% mortgage you cannot refinance (due to being underwater) at what point do you walk away from the mortgage? At what point do you walk away as an amateur landlord in a cashflow-negative house that you only bought because prices were rising fast?

[reeshau]

It's not surprsing that prices are down since 2022, since financing costs have increased.  But given how constrained the real estate market is currently, there are a number of distorting factors.  Not lease of which is the fact that new home sales are 30% of the market, instead of the historical 10-13%.  Intuitively, you would think new homes being a disproportionate amount of the market would raise prices.  However, in response to affordability issues, builders have explicitly shrunk the floorplan they are building, to get the sticker price down.  Home builders are selling home for less gross price, but making record profits as their pandemic cost pressures recede.

Case Shiller says prices are higher.  Importantly, it looks at repeat sales of homes, which is a way to take into account variability of homes sold.  (Of course, as an index of repeat sales, it will explicitly exclude new home sales)

[neo von retorch]

I think you need to remember two pretty important facts about housing:

• Housing is seasonal
• Housing is regional

Out of curiosity, I brought up housing trends in Orange County, CA. Not surprising - there's a seasonal rise and fall of prices. December is almost always the worst time to sell. April to June is almost always the peak time to sell. Regardless of national trends, long-term trends, etc. For another data point, here's King's County, WA.

Note in both, there's a big uptick in housing prices as of February 2024.

(As someone who closed on a house in mid-Februrary this year, and is about to sell a house, these trends are very interesting, but I look to the ones in my county and nearby counties for a much clearer picture.)

When you look at national statistics, it can give you some interesting information, and may reflect seasonal changes, but it is probably not a great way to predict regional trajectory.

[Paper Chaser]

It's not surprsing that prices are down since 2022, since financing costs have increased.  But given how constrained the real estate market is currently, there are a number of distorting factors.  Not lease of which is the fact that new home sales are 30% of the market, instead of the historical 10-13%.  Intuitively, you would think new homes being a disproportionate amount of the market would raise prices.  However, in response to affordability issues, builders have explicitly shrunk the floorplan they are building, to get the sticker price down.  Home builders are selling home for less gross price, but making record profits as their pandemic cost pressures recede.

Case Shiller says prices are higher.  Importantly, it looks at repeat sales of homes, which is a way to take into account variability of homes sold.  (Of course, as an index of repeat sales, it will explicitly exclude new home sales)

I think we're only now starting to see the floorplans shrink, and get decontented in response to horrible affordability for buyers. Those changes usually require lots of community level planning and zoning which takes quite awhile.

Price drops are not the only tool that New Home builders have to improve affordability for buyers. Many of the larger New Home Builders in the US also offer their own financing, and are able to buy down interest rates much lower than what a person can get on the open market. This option improves affordability for buyers, without totally killing the selling price comps. So, even though the nationwide data is showing declining prices for New Homes, that kind of obscures the real cuts being made. If financing games and other concessions were accounted for, the data would likely show even higher declines than we've seen. Same is true in rentals in many markets, where LLs may eschew dropping monthly rent, but offer 1-3 months rent free instead. They're effectively the same thing (reduction in value) but show up differently in many of the metrics that we often see/use.

[reeshau]

I think we're only now starting to see the floorplans shrink, and get decontented in response to horrible affordability for buyers. Those changes usually require lots of community level planning and zoning which takes quite awhile.

I follow homebuilders closely, and I own shares of Green Brick Partners.  Home size has been a factor affecting their reporting since at least Q3 of last year.  From the Q3 earnings call:

"Richard Costello

Thank you, Jim. Please turn to Slide 9 of the presentation. Home closings revenue for the third quarter grew 5.3% to $416 million driven by our 16% year-over-year increase in home closing units to 754 homes delivered. This is partially offset by a 9% decline in our ASP to $551,000. The decline in ASP was predominantly driven by a year-over-year increase in the percentage of Trophy Signature Homes closed as well as by a change in product mix within Trophy. In that regard, Trophy has both shifted to offering smaller square footage homes and transitioned from their most expensive houses as they close out their most prime locations.

Our homebuilding gross margin was not affected by a lower ASP. On the contrary, it has climbed each quarter since 4Q of '22 and reached a record high of 33.3% during the third quarter. This Q3 level was 90 basis points higher than our previous record set in 3Q of '22. Homebuilding gross margins have consistently been among the highest in the homebuilding industry as shown on Slide 4."

When you talk about zoning and such, I would agree if that meant densifying the neighborhood.  In this case, it is simply going with the smaller choices of the current selection, on the same lot.  This is particularly strong with spec builds.

[MrGreen]

In our area, two of DR Hortons larger communities are now offering homes that more closely resemble double-wides in the newest sections of the developments. Smaller 2-3 bedroom plans with no or 1-car garage in the 1,000-1,200 sq. ft. range.

[ChpBstrd]

Ah, so it is merely shrinkflation, not an actual decline.

Perhaps the change in psychology is around "what I need".

[EscapeVelocity2020]

Commodities rallying big time this month so far - gold, oil, silver...  GDP is strong, unemployment low...  I wonder if the Fed might start to waver on cutting rates in June?  QT taper might be seen as supportive enough.

[Financial.Velociraptor]

Commodities rallying big time this month so far - gold, oil, silver...  GDP is strong, unemployment low...  I wonder if the Fed might start to waver on cutting rates in June?  QT taper might be seen as supportive enough.

The talking heads agree that the reason the market is down two days in a row is the rise in 10 yr yield and interest rate futures showing a lot of traders expecting the rate cut to move out ANOTHER month.  I think the talking heads are right about as often as a broken clock but today seems to be their day.

[ChpBstrd]

Commodities rallying big time this month so far - gold, oil, silver...  GDP is strong, unemployment low...  I wonder if the Fed might start to waver on cutting rates in June?  QT taper might be seen as supportive enough.

The talking heads agree that the reason the market is down two days in a row is the rise in 10 yr yield and interest rate futures showing a lot of traders expecting the rate cut to move out ANOTHER month.  I think the talking heads are right about as often as a broken clock but today seems to be their day.

Yes, but this has been the pattern for a long time now. Remember in early 2023 when we were all talking about the potential for a September 2023 rate cut? Then it was November. Then it was March 2024. Then is was June 2024. Now the odds of a cut by June 2024 are down to 54% and falling.

The interesting thing is that stock valuations have held up this whole time, because at each point in the year-long journey of delay, the DCF calculations factored in rate cuts at a date a similar distance into the future. 12 months ago, rate cuts were thought to be a few months away. Today, they're still a few months away! It could be that the first rate cut doesn't occur until early 2025 but as long as expectations change over time to keep the first rate cut a few months away, we won't see a collapse in PE's, PEG's, P/S's, etc.

I do wonder if rising long-duration treasuries mean investors are starting to get impatient with paying high valuations for stocks while the rate cut assumptions that were justifications for those moves fail to materialize. The Fed's much more dovish tone is so far offsetting this growing frustration and reassuring us that rate cuts are in fact... just a few months away.

[EscapeVelocity2020]

True Chp, but this time around stocks have been in steady rally mode since last October and are at all time highs, with AI stocks and crypto at nosebleed levels...  Continuing to push out a rate cut any further than June now seems like a real disappointment.  I can't put my finger on exactly when stocks will crack, but a definitive delay on that first cut seems like it would do it.

[MrGreen]

I do wonder if rising long-duration treasuries mean investors are starting to get impatient with paying high valuations for stocks while the rate cut assumptions that were justifications for those moves fail to materialize. The Fed's much more dovish tone is so far offsetting this growing frustration and reassuring us that rate cuts are in fact... just a few months away.

The ol' Spaceballs strategy!

[Financial.Velociraptor]

Did anyone have "sudden reversal down before close going into Friday AM jobs report?"

[EscapeVelocity2020]

Did anyone have "sudden reversal down before close going into Friday AM jobs report?"

Oil going from negative to positive continues the narrative that the Fed might disappoint on a June rate cut, although nothing moving on that front yet.  More than anything, the market is probably realizing it got way ahead of itself...  Oh wait, this isn't the 'Top Is In' thread LOL

[MrGreen]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

[EscapeVelocity2020]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

This would absolutely tank the market if you're right, there is a 1.8% probability assigned to this right now, up from 1% yesterday...  It's an easy statement to speculate, but I'd probably rebalance if I really believed there was like a greater than 50% chance of no rate cuts...  Conserve that cash and continue to earn 5% on it for longer.

[ChpBstrd]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

This would absolutely tank the market if you're right, there is a 1.8% probability assigned to this right now, up from 1% yesterday...  It's an easy statement to speculate, but I'd probably rebalance if I really believed there was like a greater than 50% chance of no rate cuts...  Conserve that cash and continue to earn 5% on it for longer.

Definitely looks like an economy on the verge of overheating when we see core CPI at 3.8%, unemployment at 3.8%, GDP growth at 3.4%, and monetary velocity arcing upward. All this is occurring in an environment of positive, though not outrageous, productivity growth.

The debate within the FOMC must be about whether such numbers - if presented in isolation - actually represent a situation calling for high rates, rather than cuts. That is, if members were quizzed about a range of economic scenarios, would these sets of numbers be the ones they'd prescribe rate cuts for? Are they responding to today's data or stuck on a backward-looking narrative about falling inflation and normalizing policy for a soft landing?

It seems Fed officials will have to argue one of the following points: Either the Phillips Curve is obsolete theory (and basically we lack a working model for any of this stuff) or rates need to stay high. It's economic nihilism versus being data driven in a traditional way.

Markets are concerned the FOMC's theoretical paralysis means no rate cuts until the economic situation gets worse (which might occur due to highly positive real rates). Yet markets have their own theoretical paralysis, because things like unemployment, GDP growth, earnings, market liquidity, and asset prices should in theory be getting worse now, but instead the economy keeps getting stronger. How can this happen when the economy has NEVER IN HISTORY recovered from this scale of rate hikes without a recession in the following 3 years?

Basically the FOMC and market are both in a position where their worldviews seen to have fallen apart. For some, the natural reaction is wait and see, and for others it is buy and hold.

There's still time for the economy to suddenly go in reverse in response to the rate hikes, and still a case for economic theory and historical analysis to hold up. E.g. the last two rate hiking campaigns peaked in July 2006, and August 2023. By that logic, we are now in a place like March 2007, with the market destined to climb the wall of worry for another 6 months until the issues become acute. In hindsight, March 2007 was too early to wave the all-clear sign, disregard the housing bubble, and declare economic theory debunked.

[MrGreen]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

This would absolutely tank the market if you're right, there is a 1.8% probability assigned to this right now, up from 1% yesterday...  It's an easy statement to speculate, but I'd probably rebalance if I really believed there was like a greater than 50% chance of no rate cuts...  Conserve that cash and continue to earn 5% on it for longer.

But at what point do we go from "the market is going to tank because rates aren't coming down" to "the market hits all-time high because the economy is absolutely humming while inflation stays level albeit a tad higher than the Fed would like"? At some point, a strong economy over years merits all-time highs alone.

[EscapeVelocity2020]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

This would absolutely tank the market if you're right, there is a 1.8% probability assigned to this right now, up from 1% yesterday...  It's an easy statement to speculate, but I'd probably rebalance if I really believed there was like a greater than 50% chance of no rate cuts...  Conserve that cash and continue to earn 5% on it for longer.

But at what point do we go from "the market is going to tank because rates aren't coming down" to "the market hits all-time high because the economy is absolutely humming while inflation stays level albeit a tad higher than the Fed would like"? At some point, a strong economy over years merits all-time highs alone.

To keep the analysis simple, I think of it in terms of the last bull market that came about due to TINA.  Expectation is that real yield will go back to zero or negative by the end of this year and thus equities are going to suck cash off the sidelines.  If there are no rate cuts and real yields remain at 2%, equities right now will have been a bad bet on a risk adjusted basis.

[Financial.Velociraptor]

The most famous last (fatal) words in finance are "This time its different".  But what if it really is different this time?  There is something unique about this tightening cycle in that we started from zero for the first time ever.  The market wonks are squealing like stuck pigs about 'high' interest rates.  But in the context of the last 100 and especially last 1,000 years rates are actually still very low! 

I'm a lot more influenced by Mosler and MMT these days than Mises and the Austrian school of thought.  But I'll give a nod to proto Austrian Knut Wicksel.  Mr. Wicksel posited that there is a thing called a "natural interest rate".  This was during the time of commodity backed money but he still reasoned there was a variable rate that was optimum.  Work by some later economists basically killed usury laws across Europe and a consensus of a "good" interest rate emerged at around 5.5 to 6%.  There was no thought published on risk underwriting at the time so we have to assume that was intended to be the risk free rate. Well guess what?  The risk free rate in USA is still BELOW what centuries of economic thought says is the natural rate. 

That is to say when I say what if its different (what if it isn't) and things are conforming to traditional thought and it is the Fed that is thinking something is different when it isn't. That is, the Fed is anchored with recency bias that interest rates should be around 0% when centuries of their forebears would tell them they've lost their damn minds if they think the R* is less than about 4.5%! 

I'm increasingly of the opinion the years of extremely low rates kicked off a deluge of rent seeking behavior and, not surprisingly, hurt real capital formation.  Capex across industry, is in a real sense, driven by personal savings.  The incentive for personal savings was removed from the economy for like a decade and capital formation naturally fell.  Now that interest rates are "normal" again, capital is forming, capex is being spent (look at how much is going into electrification of transportation and AI), productive capacity and labor efficiency are rising. 

The talking heads would not like it but I think I'd be fine with higher for longer, turning into "higher forever" and we nudge the money supply around by growing or shrinking the Fed balance sheet instead of short circuiting the most important signal in economics.  Leave the damn interest rate alone and let the market make the best of it!

[dividendman]

I also feel that "this time is different" but not because of the rates per se but because there is still this underlying pessimism.

All of the economic numbers look decent, the stock market is soaring and yet a large number of people still think everything is going to hell. It seems like it's the exact opposite of the optimism that preceded the other large crashes in 2008 and 2001. As long as you have a lot of people thinking everything is bad.... can it actually be bad market-wise? I guess we'll see...

[ChpBstrd]

Scorching! Jobs report came in 50% above forecast at 303,000. I'm going to go ahead and call it. No interest rate cuts in 2024.

This would absolutely tank the market if you're right, there is a 1.8% probability assigned to this right now, up from 1% yesterday...  It's an easy statement to speculate, but I'd probably rebalance if I really believed there was like a greater than 50% chance of no rate cuts...  Conserve that cash and continue to earn 5% on it for longer.

But at what point do we go from "the market is going to tank because rates aren't coming down" to "the market hits all-time high because the economy is absolutely humming while inflation stays level albeit a tad higher than the Fed would like"? At some point, a strong economy over years merits all-time highs alone.

To keep the analysis simple, I think of it in terms of the last bull market that came about due to TINA.  Expectation is that real yield will go back to zero or negative by the end of this year and thus equities are going to suck cash off the sidelines.  If there are no rate cuts and real yields remain at 2%, equities right now will have been a bad bet on a risk adjusted basis.

In this scenario, bonds would be a bad bet too. 10-year treasuries are yielding only 4.37% today, so if the expectations for rapidly falling rates are not met, the yield curve eventually un-inverts by having the longer-term rates rise.

So maybe if the FFR settles around 4.5% a fair and historically typical value for the 10 year might be 1.5 to 2.0 percent higher than that. This would be a recipe for another bond market disaster.

The most famous last (fatal) words in finance are "This time its different".  But what if it really is different this time?  There is something unique about this tightening cycle in that we started from zero for the first time ever.  The market wonks are squealing like stuck pigs about 'high' interest rates.  But in the context of the last 100 and especially last 1,000 years rates are actually still very low! 

I'm a lot more influenced by Mosler and MMT these days than Mises and the Austrian school of thought.  But I'll give a nod to proto Austrian Knut Wicksel.  Mr. Wicksel posited that there is a thing called a "natural interest rate".  This was during the time of commodity backed money but he still reasoned there was a variable rate that was optimum.  Work by some later economists basically killed usury laws across Europe and a consensus of a "good" interest rate emerged at around 5.5 to 6%.  There was no thought published on risk underwriting at the time so we have to assume that was intended to be the risk free rate. Well guess what?  The risk free rate in USA is still BELOW what centuries of economic thought says is the natural rate. 

That is to say when I say what if its different (what if it isn't) and things are conforming to traditional thought and it is the Fed that is thinking something is different when it isn't. That is, the Fed is anchored with recency bias that interest rates should be around 0% when centuries of their forebears would tell them they've lost their damn minds if they think the R* is less than about 4.5%! 

I'm increasingly of the opinion the years of extremely low rates kicked off a deluge of rent seeking behavior and, not surprisingly, hurt real capital formation.  Capex across industry, is in a real sense, driven by personal savings.  The incentive for personal savings was removed from the economy for like a decade and capital formation naturally fell.  Now that interest rates are "normal" again, capital is forming, capex is being spent (look at how much is going into electrification of transportation and AI), productive capacity and labor efficiency are rising. 

The talking heads would not like it but I think I'd be fine with higher for longer, turning into "higher forever" and we nudge the money supply around by growing or shrinking the Fed balance sheet instead of short circuiting the most important signal in economics.  Leave the damn interest rate alone and let the market make the best of it!

Short term interest rates may be at historical norms, but longer term rates are still inverted. The economy can apparently grow just fine with a 5.5% overnight rate, but how about with a 6% 10-year treasury yield? At some number, we all get weak in the knees.

Perhaps it is recency bias that makes us think a 6% 10-year yield would be a disaster, sort of like how most people think implementing very high tax brackets on upper-income people would take the economy (it didn't in the 1950s and 1960s, when the U.S. experienced growth rates we cannot imagine today).

I think you're right about how low rates have encouraged non-productive behaviors such as rent-seeking, financial-ization of the economy, the pursuit of low-yielding business models, and asset-price gambling.

However, moving toward an economy where production is oriented toward positive-sum games and where the personal savings rate is twice what it is now comes at a cost. The flipside of normal real interest rates should be falling asset prices, lower aggregate demand, and higher unemployment. It's hard to imagine demand or business expansions increasing in response to higher financing costs (though it's arguably where we are at the moment).

I also agree the Fed should rely more on balance sheet manipulation instead of interest rate manipulation, as I've proselytized here before.

I also feel that "this time is different" but not because of the rates per se but because there is still this underlying pessimism.

All of the economic numbers look decent, the stock market is soaring and yet a large number of people still think everything is going to hell. It seems like it's the exact opposite of the optimism that preceded the other large crashes in 2008 and 2001. As long as you have a lot of people thinking everything is bad.... can it actually be bad market-wise? I guess we'll see...

I think the pessimism comes from cost-of-living increases which were not made up for with wage growth in 2021 and 2022 - especially for those who didn't switch jobs. So consumption is up, but it's because the price of consumption is up, not because people are getting more stuff. They're also not as financially resilient, as evidenced by the pitiful 3.6% personal savings rate. A bull might point out that the early 1980s were also a time of horrible sentiment, and arguably the best stock buying opportunity of the 20th century.

[Financial.Velociraptor]

<snip>The flipside of normal real interest rates should be falling asset prices, lower aggregate demand, and higher unemployment. It's hard to imagine demand or business expansions increasing in response to higher financing costs (though it's arguably where we are at the moment).
<snip>

I think the Phillips Curve is more of an observation of past correlation and not something that is necessarily causation.  What if higher (than 0 but less than 5%) interest rates, improve capital formation and lead to capex growth as per theory?  Might that capital formation create more demand for (especially skilled) labor as AI isn't far enough along for the machines to run and/or program themselves?  Today's 300k+ jobs read seems to suggest something like that is being observed. 

As to does interest rate policy effect aggregate demand, remember that AD always equals AS.  Else, an arbitrage opportunity arises somewhere in the supply chain.  If improved capital formation is driving new capex, production (AS) could in fact be going up as a result of a modestly higher than 0 interest rate!  That is, prior observations seem to indicate the very short term result of restrictive monetary policy is your "should be's"; but when you come off the zero bound to only a modest rate, the medium and long term impact might be exactly the opposite!